Watching Alejandro Inarritu’s harrowing survivalist drama “The Revenant” is an excruciating, visceral experience. For some, however, watching the mauling in the oil market over the last few years was even grislier.
Yet 2016 has provided a respite from the thrashing—oil, the wider commodity complex and resource-driven currencies have returned with a vengeance. For commodity bears like us, this revenantlike performance has inflicted some short-term pain.
Where to next? We remain steadfast that oil and commodities are in a “lower for longer” phase. Yes, stability may have finally arrived. However, a renewed bull market is unlikely.
Prices went through a very typical secular phase—rising demand amidst constrained supply in the early 2000s was met with a prodigious surge in capital spending. This imbalance ensures that commodity bear markets are longer-running affairs: Persistent oversupply imposes a ceiling on prices for years.
After The Carnage
Looking ahead, global investors should learn to love low oil prices. But investors have been treating the price decline as a leading indicator of weakness in global demand. This is evident in market action. Incongruously, correlations between oil prices and the U.S. stock market reached their highest level in more than two years in late February.
This could not last. In fact, correlations are already changing, falling from 0.67 on Feb. 26 to 0.52 on March 22 (using daily returns). For perspective, correlations have averaged 0.13 and 0.07 over the past 20 and 30 years, respectively.
As investors begin to look past the initial impact of lower oil in the sector itself, the second-order effects will become apparent. In commodity-importing countries, consumption, investment and liquidity will benefit (even in the U.S., which remains a net oil importer).
Investors are also extrapolating weak profit trends well into the future. Earnings revision ratios have only been lower during the Asian (1998) and the financial crisis (2008) crises. To be sure, aggregate sales for S&P 500 firms fell 4% year-over-year, and profits tumbled 7.5% (figures as of the fourth quarter of 2015). However, a big driver of the decline can be attributed to the energy sector. Sales in the same period dropped 34%, while profits plunged 73%.
The second-order question is whether U.S. companies more broadly will benefit given the general boost to consumption. While difficult to isolate, consumption patterns are becoming clear: Households are spending the difference. The personal savings rate has not risen materially. U.S. corporate sales will start to reflect this windfall directly ahead.